Is the US headed for recession?

You wouldn't think it to look at the US stock market, but an ongoing housing slump and rising petrol prices mean that there's a very real chance of the US slipping into recession by the end of the year.

You wouldn't think it to look at the US stock market - or global markets for that matter.

But there's a very real chance that the US will be in recession before the year is out. Former Federal Reserve chairman Alan Greenspan puts the odds at one in three - and he should know; as Robin Aspinall of Halkin Services points out, "it's his recession".

By slashing interest rates indiscriminately every time a minor slowdown threatened the American economy, he has blown a series of bubbles, with the latest one to pop being the housing bubble.

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Now his successor, Ben Bernanke, is faced with the prospect of sorting it all out. The only trouble is, things are in such a mess now that Greenspan's weapon of choice - interest rate cuts - won't work anymore

"There is no doubt there is a slowdown going on in the US," said Alan Greenspan at the end of last week. "We are clearly having troubles in the capital investment area, as well as potentially in the consumption area and obviously housing being a significant drag."

That's an understatement. US GDP growth slowed to just 1.3% in the first quarter of this year, a four-year low. The weak housing market knocked a full 1% off economic growth, as construction activity slid by 17%. Worse still, Paul Kasriel of the Northern Trust reckons that this estimate is overly optimistic - he reckons that GDP growth will be revised down to a piddling 0.8%.

There's no sign of the housing collapse slowing any time soon either. In March, existing home sales were down 8.4%, the biggest fall in 18 years.

And at the same time, petrol prices are hitting record highs. US consumers are now paying more for their gasoline than when Hurricane Katrina hammered New Orleans in 2005. The average price is now $3.07 a gallon.

While oil prices are about $10 a barrel lower than during Katrina, the trouble is with refining capacity, which is at near-15-year lows, due to maintenance problems.

That's bad news for consumer spending - if Americans are spending more on filling up their cars, that means they're spending less in the shops. And as the US economy is 70% reliant on consumer spending, that means things look likely to get worse before they get any better.

And with inflation still uncomfortably high in no small part down to petrol prices - the Fed will find it hard to justify cutting interest rates to give consumers any relief.

Some pundits argue that the weak dollar will bale the US out, as other countries import more from America. But as Kasriel points out, exports currently count for just 11.5% of US GDP - and that's already a record high.

And the problem for the rest of us is that US consumer spending isn't just important to America - those little shopaholics also account for 29% of the rest of the world's GDP. If US consumption slows down, it will slash demand for exports from the rest of the world.

That will hurt the companies involved, who will lay off workers, thus resulting in foreign consumers spending less, and therefore not buying as many US imports. So its not so much a case of "Can the rest of the world save the US economy?" It's more a case of "Can the rest of the world break free of the US before it pulls everyone else into recession with it?"

Currently the general consensus is that growth in Asia and Europe will compensate for any US downturn, but Morgan Stanley global economist Stephen Roach is not optimistic.

Just to take a few examples, Mexico and Canada rely on exports to the US for about 25% of GDP. US exports account for 6% of Chinese GDP; and more than 10% of the Thai, Indonesian and Malaysian economies, he says.

All this might not be a problem just maybe if the US simply had a calm, measured slowdown. But in reality, the current situation could rapidly turn into a full-blown recession. Roach believes that with housing in freefall, unemployment in America is likely to pick up soon, which will "only increase the odds of a consumer retrenchment."

If he's right, and "the lead engine of the global growth train goes off the tracks, the rest of the world will be quick to follow and the hopes and dreams of global decoupling will be in tatters."

Our own James Ferguson certainly agrees with Roach on the US economy. As James recently reminded us, most US leading indicators are pointing to recession, and one of the few that isn't - retail sales - is very very close to doing so. That's bad news for the US and by extension, almost certainly bad news for the rest of us.

Turning to the wider markets

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In London, a weak mining sector dragged the FTSE 100 down 10 points to a close of 6,555. Rio Tinto and Lonmin were hit by broker downgrades whilst the falling price of copper and aluminium weighed on others including Antofagasta. However, it was a bright day for British Gas owner Centrica which rose 2% following an upbeat AGM statement. For a full market report, see: London market close.

Elsewhere in Europe, the Paris CAC-40 closed down 24 points, at 6,026, on profit-taking. In Frankfurt, meanwhile, the DAX-30 ended the day 19 points lower, at 7,459, despite gains for car giant Daimler-Chrysler which rose nearly 2% on news that the it is to sell an 80.1% stake in its US unit to Cerberus Capital Management.

On Wall Street, the beleaguered auto sector was given a boost by the Chrysler deal, with Ford and General Motors both rallying. However, trading was generally subdued as investors consolidated gains ahead of today's inflation data. The Dow Jones climbed 20 points to end the day at 13,346. The Nasdaq fell 15 points to end the day at 2,546. And the S&P 500 was down 2 points at 1,503.

In Asia, the Nikkei fell as data showed an unexpected decline in Japanese machinery orders. The index was down 164 points at 17,512.

Crude oil was little changed at $62.43 this morning, whilst Brent spot had fallen to $66.02.

Spot gold had risen to $669.50 this morning and silver had edged up to $13.12.

Turning to currencies, the pound had risen to 1.9804 against the dolllar and was at 1.4622 against the euro. Meanwhile, the dollar was at 0.7382 against the euro and 120.27 against the Japanese yen.

And in London this morning, Thomson Corp. agreed to buy Reuters for £8.7bn in a deal which will create the world's largest news and financial information company. Reuters shares were up by as much as 3.6% in early trading, although those in Canadian firm Thomson fell by 0.8% in Toronto yesterday.

And our two recommended articles for today...

Should you rely on property as your pension?

- Almost one-third of Britons aim to use equity from their homes as one of the main ways to finance their retirement. But bearing in mind an unreliable market and myriad hidden costs, Merryn Somerset Webb is unconvinced. To find out where you should be investing for your old age instead, read: Should you rely on property as your pension?

What the 5.5% UK base rate means for markets

- As everyone knows, the Bank of England's decision to hike interest rates last week is set to make life much more difficult for homeowners. But what about the commercial property market? And how much influence does monetary policy really have on equities? For more on the effects of the current UK interest rate - plus what the leading market indicators are telling us, click here: What the 5.5% base rate means for markets

John Stepek

John is the executive editor of MoneyWeek and writes our daily investment email, Money Morning. John graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.

He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news. John joined MoneyWeek in 2005.

His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.